Gordon Long: The Jaws of Death

from Gordon Long's Tipping Points:

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PRESERVE & PROTECT

 

The Jaws of Death

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The United States is facing both a structural and demand problem - it is not the cyclical recessionary business cycle or the fallout of a credit supply crisis which the Washington spin would have you believe.

 

It is my opinion that the Washington political machine is being forced to take this position, because it simply does not know what to do about the real dilemma associated with the implications of the massive structural debt and deficits facing the US.  This is a politically dangerous predicament because the reality is we are on the cusp of an imminent and significant collapse in the standard of living for most Americans.

 

The politicos’ proven tool of stimulus spending, which has been the silver bullet solution for decades to everything that has even hinted of being a problem, is clearly no longer working. Monetary and Fiscal policy are presently no match for the collapse of the Shadow Banking System. A $2.1 Trillion YTD drop in Shadow Banking Liabilities has become an insurmountable problem for the Federal Reserve without a further and dramatic increase in Quantitative Easing. The fallout from this action will be an intractable problem which we will face for the next five to eight years, resulting in the 'Jaws of Death' for the American public.

 

The ‘Jaws of Death’ is the crushing squeeze of a shrinking gap between incomes and a rising burden of the real cost of debt burdens. Many may say there is nothing new in this, but I would respectfully disagree. There is a widespread misperception of what is actually evolving that stops voters from forcing politicians to address America’s substantial underlying dilemma.  It also stops investors from positioning themselves correctly.

 

Any solutions of real substance are presently considered political suicide. It is wiser to wait for a crisis event to unfold. As White House Chief of Staff and a primary Obama political strategist, Rahm Emanuel has said on numerous occasions: “You never want a serious crisis to go to waste”. It doesn’t take much intelligence to understand this also implies looking for a crisis as a political shield, for example from an almost insurmountable political problem such as a generational reduction in the US standard of living.

 

Before I delve into misperceptions of the ‘Jaws of Death’ and a reduced US standard of living, we need to briefly consider for a moment whether this is a planned outcome or just happenstance? President Franklin Roosevelt said:

“Nothing in politics happens by chance”.

 

Being in business I have always been very watchful of a slightly different variation of the same theme:

 

“Strategy is something that happens to you while you are looking the other way”.

 

Maybe Mark Twain said it better than both of us:

 

“It ain’t what you don’t know that gets you into trouble. It’s what you know for sure and just ain’t so!”

 

My point is that there is a strong possibility that the ‘Jaws of Death’ is an orchestrated plan to reposition America’s standard of living. A plan not for the good of Americans but for the good of the banks and those that control the $630 Trillion unregulated, off shore, off balance sheet, OTC derivative market. It is no secret that America’s standard of living is no longer viable, as evidenced by a continuous and chronic deterioration in the US Balance of Payments, Trade Deficit and Current Account funding. It must be addressed and this may already be happening in a stealth fashion.

 

What the above suggests is that we need to address what is perceived as ‘truisms’ but in fact are not;  what is perceived as reality versus what is perception. These subtleties are the veils that hide the real dangers from us.

 

 

THREE MISPERCEPTIONS

 

1-    1- Housing

 

Consider President George W. Bush’s ‘ownership society’ where it was heralded, along with the previous Clinton administration, that every American should own his/her own home. It is fair to say that our society bought into this ‘hook, line and sinker’.  I used to hear the following statements endlessly, and disputing any of them fell on deaf ears with blank stares, as though you were an idiot to even challenge them.

 

THE MANTRA	BEHAVIOURAL RESPONSE
“Housing and Real Estate are the best investments you can make”	Residential Real Estate became the public’s ‘savings’ strategy (in most cases their sole savings strategy).
“My house is my retirement nest egg. I will sell it and move into something less expensive when the time comes”	Residential Real Estate became the Public’s  Retirement Strategy and source of financial security.
“We have made a lot of money on the appreciation of our house”	The Emotional Wealth Effect justified increased spending on vacations, hobbies and luxury items (through increased debt).
“Money is so cheap my financial advisor suggested I should take out  a Home Equity Loan as a wealth ‘extraction’ strategy”	Perceived low rates justified spending and increasing debt. Home Equity Lines of Credit & Loans (HELOCS) exploded.
“They aren’t making any more land!”	A sense of urgency was created that if you didn’t quickly take on horrendous levels of debt you would never be able to afford your piece of the American dream.

 

I can’t remember how long it has been since I have heard any of these statements.  How quickly accepted fact is found to be mistaken. Without this false mantra being sold to the public we would never have had a CDO driven financial crisis. Consider for a moment who is responsible for orchestrating this false belief system that the financial collapse was built on? Our government's misguided public policy certainly holds some responsibility for this.

 

2005	2010

 

“The public and majority of investors are always wrong.”

 

What we now face is the reality that jobs have disappeared and housing has fallen in an almost mirror image of unemployment as shown by housing starts below.

 

 

According to a recent 3,400 households’ survey by Fannie Mae, a more realistic attitude towards homeownership has emerged as the American dream of owning a home has lost its allure. Only 67% felt housing was any longer a safe investment and 33% said they were likely to rent in the future. The Wall Street Journal recently cited an interesting illustrative example of shifting psychology in which a 26 year graduate student walked away from his down payment to purchase a condo because he felt homeownership was an “economic trap” and “being mobile and adaptable to the job market was far more important than homeownership”.

 

The National Association of Realtors is starting to show signs of panic because this shifting psychology is moving legislators to reconsider federal subsidies for homeownership. It has reacted by launching a campaign on the “value of homeownership”. I wonder if the National Association will get the same look I did when I questioned the housing statements listed above.  Oh how quickly things change!

 

2-    2- Inflation / Deflation

 

I am continuously troubled by the inflation – deflation debate. One of a number of issues in these debates that concerns me is no one ever defines ‘time’ in their analysis and predictions. Without time specified we could have inflation, then deflation, (or visa-versa) for exactly the reasons that both opposing views meticulously articulate. Maybe even more blatant is that seldom do analysts consider the possibility that we could have both. This is the school that I am a believer in.

 

I predict that over the next few years we will have inflation in the things we NEED and USE. These are the items we buy and consume every week, the items we buy and not finance, and the items we need ready and recurring cash for. Food, energy, consumables, and basic services are examples.

 

We will have deflation in the things we WANT and OWN. These are the items we strive for that we perceive will move our lives to an even higher standard of living. They are primarily assets like: housing, real estate, financial instruments, boats, exotic cars, art, collectibles, etc. - often the items we finance.

 

It may be as simple as Maslow's Hierarchy of Needs; until our survival needs are met we won’t move towards the ultimate state of self actualization. We won’t think of luxury goods when we are hungry, cold and tired. But what is pushing us towards the ‘survival’ end of Maslow’s spectrum? If we live on debt and it becomes harder to secure or service, then this will accomplish that shift, despite new debt being cheaper than it previously was.

 

Money supply which is a driver of monetary inflation and deflation is now negative, as shown by the broader M3 money supply (which is no longer reported by the government). This illustrates that despite massive monetary intervention, forced deleveraging of mal-investments has come home to roost.

 

3-    3- Credit Availability versus Credit Demand & Debt Servicing

 

Thirdly, only a few years ago interest rates were considered low and widespread refinancing was occurring. Home equity loans were all the rage to buy new boats, campers, vacation homes and every other imaginable toy that cheap money was felt to afford. Advertising was replete every evening with 0/0/0 financing offers: Zero down payment, zero payments for 48/60 months and zero interest. Who could refrain from taking advantage of these incredible offers?

 

 

Well guess what? Interest rates are now significantly lower and the products you bought previously are in most instances now even cheaper; yet few are clamoring for them.  At the marina where my boat is moored, you can’t give away a boat; where only a few years ago no one could get a mooring or slip for their newly purchased boat.  What has changed is we can generally no longer service our debt loads at even present historic 50 year low interest rate levels. Heaven forbid rates should go up!

 

The central issue may be not about whether rates go up, but rather if the above outlined housing weakness, concurrent inflation/deflation and weak credit demand persist for a protracted period.

 

I would like to show you exactly what this means if these trends persist, by using a fictional family as a way of illustrating what is now in store for the public.

 

THE SMITH FAMILY DILEMMA

 

The Smith family bought into all this mantra by purchasing a home. All their peers were doing it. Their family kept asking them why they hadn’t bought a home; and if they didn’t, they would surely never be able to afford one. They felt pressured to take on the debt obligations. Unlike many, they were relatively conservative and bought a home with a small down payment, securing a $200,000 mortgage at 6.5% fixed for 5 years. The mortgage was possible because they absorbed Private Mortgage Insurance (PMI) payments into their monthly budget. The family income was $50,000 annually. These are all nominal prices. To adjust for real values, we need to subtract the inflation rate from the mortgage rate. Inflation helps the Smith’s get ahead over the leveraged housing asset. The higher the inflation rate above 6.5% the more they win. The drawback is that their $50,000 income diminishes in real value. The salary therefore needs to be adjusted for real terms by subtracting the inflation rate from the $50,000.  Here are the theoretical results for various Deflation, Inflation and Hyper-Inflation scenarios.

 

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As bad as the above theoretical charts look, it is actually worse in reality.  Why? Because as the pressures mount on unemployment, underemployment and competition for jobs, money becomes tougher and harder to earn. As disinflationary pressures shift to deflationary pressures, housing prices fall faster than the overall inflation/deflation rate. As a matter of fact they fall substantially faster. The following table represents the same numbers for the Smith family, but I have adjusted for the variance in house prices falling faster than the overall deflation rate. This is where it gets really scary.

 

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What the charts tell us is that if present Monetary and Fiscal Policy is anything other than totally successful in arresting deflation and creating balanced inflation in both what we USE and OWN, we are in serious troubles. Any imbalances will be a disaster as shown on our charts. A failure to stop deflation will be devastating to those who are in highly leveraged assets.

 

If after reading the former example of the Smith Family you discarded it because you strongly believe elevated inflation is around the corner and you are a highly leveraged home owner, let me take you through a brief quiz published by The Daily Bell  to further test your understanding of reality: “The Great Housing Bamboozle: A Look Behind The Numbers Shows Home Ownership To Be A Horrible Investment”.

 

Family A, an average American couple, buy the average American home in 1980. They pay the average American price ($76,400) and take out the average American mortgage. 29 years later, they sell the home to another couple for the 2009 average American price of $270,900. How much did they profit from the sale (assume the mortgage has been paid in full)?	A: $194,500
According to the BLS, cumulative inflation from 1980 to 2009 was 160.36%.  a) What is the simple inflation adjusted value of the house?  b) How much of Family A’s profit was the result of inflation and,  c) How much was their profit after inflation?	a) $198,915.04 ($76,400 * 2.6036)   b) $122,515.04 ($198,915.04 – 76,400)   c) $ 71,984.96 ($270,900 – $198,915.04)
Well, there is one other factor we should probably consider: the effect interest rates had on the value of the Family A’s “investment”. After all, refinancing the house at ever lower interest rates is how they paid for that boat in the driveway, a marina slip and everything else that went with the new boat. God knows it wasn’t their ability to earn more.   Question #3 –The average 1980 mortgage was 14.005% APR (13.74% with 1.8 pts.) and the couple that bought it, Family B, got 5.1015% APR (5.04% with 0.7 pts plus cool cash from Uncle Sam). Their 30-year fixed mortgage payments are $1471.10. a) How big a mortgage would that payment get if interest rates were the same as in 1980? b) How much of the Family A’s “profit” can be directly attributed to the change in interest rates?	a) $124,206 (you’ll need Excel to calculate this)   b) $146,694 ($270,900 – $124,206)
Question #4 –So there you have it. 74% of the Family A’s gain can be attributed to the 9% drop in interest rate. When you strip out the interest rate effect, the house underperformed inflation by more than 60% over 30 years (and that’s excluding all other costs associated with the American dream), which of course means this wasn’t actually an investment at all.   How many Americans understand this?	A: Not many. Somehow the mathematical realities of the US housing market have completely escaped the education-loving American public as they continue to assume that the next thirty years will yield results similar to the last thirty. Utterly freaking impossible. We can’t drop mortgage interest rates 9% again (currently 4.4%), but we should expect houses to continue to underperform inflation.

 

 

WHAT ARE THE CHANCES OF HOUSING FALLING FURTHER?

As I mentioned previously, attitudes towards housing as an investment have changed. There has been enough written on the housing decline but surprisingly little on how much further it is likely to go or whether it should be considered an investment at all.

 

Even after massive assistance in the form of HAMP, over $1T of government purchases of Government Agency debt, 50 year low interest rates and Quantitative Easing, the Federal Reserve’s monetary policy and the US fiscal policy has been unsuccessful in reversing the housing decline. New Sales, Housing Starts and Building Permits continue to deteriorate as housing inventories once again resume their climb with untold amounts of ‘shadow’ inventory still being held back from foreclosure by the banks.

 

Karl Case, the co-founder of the S&P/Case-Shiller home-price index, believes “a common mistake of the housing bubble years was the desire to own something that goes up in value rather than to own something you can afford”. He feels “more Americans need to view homes as durable goods, such as cars, and not primarily as investments”.

 

Housing is not coming back soon and I suspect we are still in the middle stages of a longer term housing correction. Historically, major financial distortions always return to at least retest their long term trend support. By various comparisons we still have a fair ways to go over the next two years.

 

 

PEOPLE ARE STILL HURTING – IT ISN’T GETTING BETTER!

 

A recent convention in Palm Beach Florida attracted over 50,000 people, estimated to be holding 25,000 problem mortgages. This is after the government placed Fannie and Freddie in conservatorship and bought over $1T in agency mortgages to keep the US mortgage system from imploding.

 

 

FHA will soon be in a similar untenable position as the government has become the holder of almost all new US mortgage product. If this is not sustained, despite it being a near impossibility to do such, US housing may not just fall further but collapse.

 

CONCLUSION

 

“The great enemy of the truth is very often not the lie – deliberate, contrived and dishonest – but the myth – persistent, persuasive and unrealistic.”

 John F. Kennedy

1962 commencement address at Yale University

 

Americans must face the hard reality that the US is now in decline and rapidly relinquishing its hold as the world’s dominant industrial power.  A serious failure in political leadership to recognize this and act upon it, along with misguided public policy legislation, has hastened the decline.

 

What this means is that America’s standard of living, which has almost been assumed as a birthright, is now in jeopardy and for the middle class is already in full erosion. America, like all great powers in decline, has become complacent and apathetic with an unjustified sense of entitlement. Americans somehow believe that bad things cannot befall America, as though it is preordained to always be a preeminent power with the corresponding highest standard of living.

 

The facts are that we are at the precipice of a crushing decline in our standard of living due to fifty years of wasteful spending and bad public policy. We are near or now possibly past the point of no return without bold and rapid change. We need change that can only come from the public’s understanding of what change specifically is required and not just a political billboard proclaiming the ‘change’ mantra at election time.

 

As we move more and more towards a “have” and “have not” society where the middle class is disappearing and the government is involved in all aspects of our lives and economic well being, we are becoming acutely aware that America is now different. Our perceptions of what America is no longer matches the reality around us on a daily basis. The middle class in America is rapidly disappearing.

 

DISTRACTION	REALITY
Inflation lies ahead due to all the Government money printing. Deflation lies ahead due to deleveraging and banking problems.	Deflation & Inflation both lie ahead. - Inflation in what we NEED and USE - Deflation in what we WANT and  OWN
Unemployment is a temporary problem due to a protracted recessionary recovery.	Employment is a long term chronic problem that is structural in nature.
Credit Availability will re-ignite the economy.	Easy credit is the hole we must dig ourselves out of.
Bank Lending is the problem.	Borrowing is the problem – insufficient collateral and qualified borrowers.

 

Like housing being a good investment, much of what we hear or believe are false perceptions. We are distracted by these contrived and orchestrated misperceptions from the hard reality in taking the actions required to make real needed change. The US Standard of Living is now on the line.

 

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Pensions in Peril: "A Death Spiral"

from MoneyNews.com

U.S. state pensions such as Illinois, Kansas and New Jersey are in a “death spiral,” with assets at many insufficient to cover benefits, payouts consuming a growing portion of resources and costs rising twice as fast as investment gains.
Less than half the 50 state retirement systems had assets to pay for 80 percent of promised benefits in their 2009 fiscal years, according to data compiled for the Bloomberg Cities and Debt Briefing in New York today. Two years earlier, only 19 missed the mark. Illinois covered just 50.6 percent of benefits last year, the lowest so-called funded ratio, which actuaries say shouldn’t be less than 80 percent.
Benefits paid by funds in at least 14 states equaled more than 10 percent of assets in the fiscal year, the figures show. In 2007, none exceeded the threshold. The growing burden prompted Colorado, Minnesota, Michigan and other states to trim benefits for millions of teachers and government workers. It also forced fund managers to keep money in short-term low-return investments to pay benefits, reducing chances pensions can earn their way back to financial health.
“Once you get into that dynamic, you’re in a death spiral,” said Michael Aronstein, who manages the $295 million Marketfield Fund of stocks as chief investment strategist at Oscar Gruss & Son, a New York brokerage. “There’s no financial or return solution.”
The largest Illinois pension, the $33 billion Illinois Teachers’ Retirement System, paid $3.7 billion of benefits in the year ended June 30, 2009. That’s 13 percent of its assets at the time, up from 8 percent two years earlier, according to annual reports and Dave Urbanek, its spokesman. The New York State system, the best-funded in the Bloomberg data at 107.4 percent, paid out 7 percent of its assets in fiscal 2009.
Shoring Up the System
At June 30, 2010, after the Illinois fund’s investments had gained 13 percent and lawmakers borrowed $3.5 billion to shore up the system, benefits in the fiscal year had risen to $3.9 billion, according to Urbanek, or 12 percent of assets.
Lawmakers in Illinois, which, with California, has the lowest credit rating from Moody’s Investors Service of any state, were unwilling to approve another bond sale, for $3.7 billion, this fiscal year. As a result, the pension may sell $3 billion of assets to cover benefits, Urbanek said.
“Death spiral is too harsh a language,” he said. “It’s a concern, but we’re not on life-support.”
Selling assets, reducing services and cutting costs such as pension contributions are tactics states are using to confront what a June 29 report by the Center on Budget and Policy Priorities, a Washington-based research group, said was a record $140 billion combined budget deficit this fiscal year.
Anger Management
Lawmakers are willing to anger taxpayers and retirees to show investors who buy more than $400 billion of state and local debt a year that something is being done to stem rising costs.
Benefits paid by the 100 largest public pensions in the five years that ended June 30 grew an average of 8 percent annually, calculations based on U.S. Census Bureau reports show. In that period, the median annualized investment return was about 3 percent for public funds with more than $5 billion of assets, said an August report from Wilshire Associates, an investment adviser in Santa Monica, California.
The U.S. recession and stock-market collapse drained about $835 billion of value from the 100 largest public funds, according to the Census Bureau. As a result, benefit payments by those funds amounted to 7.5 percent of assets in the 12 months ended June 30, 2009, up from about 5 percent two years earlier, the census figures show.
Unaltered Trend
Even an investment rebound in the year that ended June 30, 2010, when Wilshire reported the median return on public retirement funds was about 13 percent, did little to alter the trend. Funds in at least eight states that reported investment results for the fiscal year still spent more than 10 percent of their assets on benefits, Bloomberg data show.
“The fact such a large portion of assets is flowing out each year really challenges the longevity of these funds,” said Joshua Rauh, who teaches finance at Northwestern University in Evanston, Illinois. He projected retirement accounts in his and other states would run out of money within a decade. “It will be a crash landing,” he said.
The rising share of assets consumed by benefits is “interesting” but misleading, said Keith Brainard, research director of the Baton Rouge, Louisiana-based National Association of State Retirement Administrators. He pointed to the offsetting effect of annual payments into funds made by workers and state governments.
“Employer contributions tend to fluctuate, but employee contributions are remarkably steady,” he said.
Unequal Gains
From 1998 to 2008, the most recent full statistics from the Census Bureau, state and local government payments into retirement funds almost doubled to $82 billion. Over the period, worker contributions rose 70 percent to $37 billion.
During the same decade, however, benefits paid increased by 130 percent to $175 billion. Payments from the 100 largest public funds grew by another 9 percent during the first three quarters of the 2010 fiscal year compared to the first three quarters of 2009, according to the census.
The $11 billion Kansas Public Employees Retirement System had the seventh-lowest funded ratio in Bloomberg’s ranking at 63.7 percent in 2009. It paid out benefits equal to 10 percent of its assets in the fiscal year, double the rate of 2007, fund records show.
The pension’s funded ratio fell from 70.8 percent two years earlier and is projected to drop to 41 percent by 2015, according to a February report to state lawmakers. Another market decline could jeopardize the fund, the report said.
Capital Preservation
“Preservation of sufficient cash flow to fund current benefits may become paramount,” it said, which could constrain investment strategies and make it harder to achieve assumed returns.
The problem is magnified in states where officials skipped billions of dollars of contributions.
New Jersey Governor Chris Christie, 48, a Republican who took office in January, withheld $3.1 billion of payments in his first budget to cope with a record $10.7 billion deficit. Since 2004, the state has made only $2.7 billion of the $11.9 billion in scheduled contributions, according to bond-sale documents.
New Jersey’s $68 billion retirement system had a funded ratio of 66.1 percent in the Bloomberg data, the 11th-lowest. The state in August settled Securities and Exchange Commission claims that it failed to disclose the extent of its underfunding in documents for $26 billion in bond sales from 2001 to 2007. It didn’t admit wrongdoing.
Projected Payments
Benefit payments are projected at 11.4 percent of available pension assets during this budget year, even after a 14 percent investment gain in the fiscal period that ended June 30, New Jersey records show.
Payouts by the New Jersey Teachers Pension and Annuity Fund, which serves about 236,000 working and retired educators, grew to $2.8 billion from $1 billion in the 10 years through 2009, an average annual increase of about 10.4 percent, its yearly reports show. Over the period, holdings returned an annualized 2.3 percent, according to the state’s Division of Investment.
Retiree benefits last year amounted to 11.2 percent of the fund’s $25 billion value, compared to 3 percent a decade earlier. Payments are on track to exceed 11 percent of assets again this year, state budget documents say.
Prescription for Health
To remain healthy, the New Jersey teachers fund should pay out no more than 9 percent of its assets each year, Scott Porter, of the Philadelphia office of Milliman Inc., the fund’s actuary, told trustees in February. He said benefit costs will rise to $4 billion a year within a decade, making it questionable the state will achieve its assumed 8.25 percent annual investment gain.
“As baby boomers retire and the benefit payments increase, that’s going to keep the market value of assets from growing substantially,” he said.
With such prospects, U.S. governors and lawmakers are proposing lower benefits. Colorado, Minnesota and Michigan are in court defending cuts, including a reduction in annual cost- of-living increases imposed on retirees during the last year.
In Connecticut, where benefit payments rose to $2.7 billion this year from $2.1 billion in 2007 as assets lost almost $5 billion in value, outgoing governor Jodi Rell wants to eliminate guaranteed pension payments for future employees. New Jersey’s Christie plans to revoke a 9 percent increase in benefits awarded in 2001.
Advocates for pensioners say such strategies illegally renege on promises to workers. Politicians themselves caused the problem by failing to make required payments, they say.
“This has been in motion for a long time,” said John Stember, a partner at Stember Feinstein Doyle Payne & Cordes in Pittsburgh, which represents retirees in six states challenging rollbacks.
“The state is making a compelling argument based on a set of facts it’s confronted with now, but that it didn’t necessarily have to be confronted by,” he said.

Future History: What Will Is Look Like As Economic Reality Sets In?

from globalintelligence.com

Fear and uncertainty create patterns, paths of their own. And societies are again in a mosaic of uncertainty — and resultant fear — over the fate and durability of the social and security frameworks once taken for granted. Mass reaction to these fears will trigger transformative change. But there will be opportunities to seize and command change.
Almost all societies in the world have gone beyond the stage where they expect stability and linear progressions of the past to long endure. Some societies — almost en bloc — anticipate the end of their security; others anticipate the end of their suffering. Few expect insulation from change. That change, however, need not be entirely inscrutable if we look at global patterns and at historical human behaviour.
Economic Patterns: What we now call “economics” determines power and conflict patterns because wealth, or the deprivation of it, determines survival, and, for those who survive, “economics” determines the relative control they may have over individual and societal destiny. Thus social behavior determines economic viability, and the failure or success of economic patterns determines social corrective or compounding action.
We are about to see an acceleration of social reaction to economic failure - a reaction to the inflexibility of policies which have failed to adjust to changing circumstances.
Many finance ministers are speaking, still, as though their national economies can perform well with just minor adjustment to old patterns. This may not be so, particularly in the West, where the rapid growth in state revenues since the end of the Cold War pushed governments down the path of highly capital-intensive programs in areas which absolutely do not contribute to national productivity in essential manufactures or primary industry, and in many cases actually constrain productivity rises. As wealth grew, and tax revenues rose commensurately, the logical approaches of governments in market economies should have been to reduce taxation and further stimulate investment.
This occurred only rarely and incompletely. Taxpayers, also benefiting from rising wealth, themselves did not demand that governments constrain their spending. The situation thus created massive state sector positions in the Western economies. When recession strikes, industry and private citizens scale back and pay the price, but governments are less flexible. Unions and state workers make themselves immune to cuts and to the realities of the “real world”.
In countries such as Greece, France, Spain, Portugal, and so on (and now the US, UK, Australia, etc.), those in the private sector who have come to rely on state handouts — and therefore become “agents” for statism, and by default are opposed to market freedom — compound the entrenched political class’ view that the state should not undergo the kind of profound self-analysis and restructuring which the private sector must embrace.
The US, Australia, Greece, and so on, as just a few examples, are undergoing per capita productivity declines just at the time when they need to be developing a strategic buffer of internally-balanced economies and the ability to better compete internationally. And there is a fear that if wasteful government spending on huge capital projects ceases, then economies will collapse.
This fearful, selfish, and ignorant intellectual process within governments has been caused by the hubris generated by unfettered control of great wealth, and the presses which print the money. But governments only have the ability, in real terms, to dominate the non-productive — or, at best, productivity-enabling infrastructure — spending. Only by returning spending power to the innovative sections of society (in other words, the people) can economies become nimble and productive.
This is unlikely to happen, so we should expect sudden contractions in buying power in many Western states over the coming few years.
We are also already witnessing the contraction of some aspects of multinational mechanisms to amass and deploy capital wherever the market determines it can profitably be invested. Part of this contraction derives from the situation in which the world is entering a period where it may soon be without a viable global reserve currency. This in turn leads to the point where trade becomes more bilateral; investment scope becomes limited in some respects; and nationalism — and with it, protectionism — revives out of economic necessity.
There have been many factors leading to the revival of nationalism since the collapse of the brief (45 year) bipolar global strategic framework in 1990-91, and these were touched upon (certainly by this writer) from 1990 onward. So the seeming uncertainty in which we now find ourselves did not emerge suddenly or without understandable cause.
Perhaps, then, our “uncertainty” is not so uncertain?
Strategic Patterns: What clarity is emerging?
• Western economies will continue to decline, in real and strategic terms (if not in nominal accounting terms), unless truly radical re-structuring occurs, including the rapid and massive reduction of the size of government intervention in economies. This means an end to the era of entitlement welfare. However,
• No democratically-elected government will dare face voters if it reduces “bread for the masses”, that method of cheaply buying votes. So most governments will continue to jeopardize their nations — by continuing the bribery of the electorate — in order to remain in office. Change, then, should only be expected through the appearance of massive threat, or national collapse, enabling the emergence of decisive leadership not based on the popular vote.
• Those states which abandon forms of taxation (such as those based on carbon emissions) which curb productivity will fare better than those which do not.
The immediate future, then, will be commanded not by electoral “democracies”, but by decisive non-populist leaders who truly return productivity to the marketplace.
Russia and the People’s Republic of China are thus favored.
By. Gregory Copley

ECB Initiates New Program of Quantitative Easing (Monetization of Eurozone Debt)

If the Eurozone Central Bank is so "confident" of growth as they say, then why would this be necessary at all? These are not the actions of confidence, but of desperation!

from EuroIntelligence.com:

So much for phasing out the bond purchasing programme. The latest weekly ECB data suggest that the ECB bought €237m worth sovereign bonds last week, the highest since the middle of August, according to the FT. Still small in absolute size, the paper notes, it is a sign of continuing problems in eurozone bond markets. Irish traders last week reported that the ECB had been in the market to support Irish bonds, whose yield spread to German bunds rose to new record levels. The article suggested that the ECB was also buying Greek and Portuguese bonds.

About that ECB’s exit strategy

Ralph Atkins and David Oakley have an excellent analysis in the FT about the change in the ECB’s exit strategy. While a year ago it was the conventional wisdom inside the ECB that the banking support policy would have to be phased out, and only then could interest rates rise. That is no longer so. As banks have become dependent on generous ECB liquidity support, it is possible that the monetary tightening occurs while the liquidity policies are still in place.

European Commission optimistic about eurozone

The European Commission published its autumn forecast and, as ever, the news coverage is taking a national angle on this. El Pais is worrying about increasing growth divergences in the eurozone, with Spain falling far behind Germany with its 3.4% growth rate. The Portuguese newspaper Negocios didn’t even bother to report about any other country but Portugal, reporting that the European Commission said that Portugal has “an opportunity to recover” but that it must “intensify consolidation”.    For the eurozone as a whole GDP is forecasted to rise 1.7% this year (rather than  a previously projected 0.9%). La Repubblica picks on the Commission’s warning that labour market dynamics are still fragile.

The Economics of Mass Destruction, Part II

by Jeff Harding at Daily Capitalist blog:

The Fallout of Economic Conformity

The logical conclusion of these failed policies is economic stagnation. Here is what massive government spending and taxation has done to our economy:

1. Total government (federal, state, and local) share of the economy has exceeded the tipping point, estimated to be between 15% and 20%, which is the point when it hinders economic growth. Presently total government spending for 2010 is estimated to be about 47% of the economy.
2. Taxation must rise substantially in order to pay for government debt, health and welfare entitlements, and other fixed government costs. The 2010 estimate of federal, state, and local taxes amount to about 30.4% of GDP (about $4.480 trillion).
3. Our total government debt (federal, state, and local) is estimated to be $16.635 trillion for 2010, approximately at 114% of our GDP (2010 E$14.623 trillion). Of total government debt, federal debt is estimated to be $13.787 trillion in 2010.

f=federal govt.; s=state govt.; l=local govt.

The larger the share of governments’ take of capital out the economy, the less money there is available for businesses and consumers. The less capital available for the private economy, the less it will expand, and the result will be a decline in GDP.
While progressive utopians believe that taxation of the “rich” is acceptable to fund social benefits, mathematics, demographics, and the laws of economics prove them wrong. Progressives have yet to understand that government produces nothing.
The table, below, shows tax rates of many major economies as a share of their GDP. The welfare states have taxes approaching 50% of their economies, with the median in the high 30^th percentile. The U.S.’s tax burden on the economy of 30.4% is less than most of these countries. While we ramp up our welfare state which assures higher taxes, Europe’s welfare state services are crumbling and face drastic shortfalls as their GDP falls, as their populations age, and as their companies find better conditions abroad.

The Economics of Mass Destruction
The Organisation For Economic Co-Operation And Development (OECD) is an economic think tank put together by 33 countries of which the U.S. is a member (see above chart for members). Most members are economic powers. China and India are not members. It generates a lot of data, but very little useful research. It is located in Paris and has 2,500 international staff members. They take a rather hard Keynesian line. One need only look at their logo to see where they stand:

The OECD just came out with their Interim Economic Assessment, “Recovery slowing amid increased uncertainty” said the headline. They, like the Obama Administration are realizing that their Keynesian policies are failing.

The world economic recovery may be slowing faster than previously anticipated, according the OECD’s latest Interim Economic Assessment. Growth in the Group of Seven countries is expected to be around 1½ per cent on an annualized basis in the second half of 2010 compared with the previous estimate of around 2½ per cent in the OECD’s May Economic Outlook.
The OECD says the loss of momentum in the recovery is temporary although uncertainty has increased. …
If the slowdown reflects longer-lasting forces bearing down on activity, additional monetary stimulus might be warranted in the form of quantitative easing and commitment to close-to-zero policy interest rates for a long period,” the OECD said. “Where public finances permit, planned fiscal consolidation could be delayed. [my emphasis]

It is clear that the OECD does not understand what is happening. Otherwise they wouldn’t need to suggest more fiscal and monetary stimulus if they really believed the “loss of momentum in the recovery” was only “temporary.”
Its announcement sounds almost as if the Fed had written it. Here’s what Chairman Bernanke said on August 27, 2010:

Overall, the incoming data suggest that the recovery of output and employment in the United States has slowed in recent months, to a pace somewhat weaker than most FOMC participants projected earlier this year.  …
We will continue to monitor economic developments closely and to evaluate whether additional monetary easing would be beneficial. In particular, the Committee is prepared to provide additional monetary accommodation through unconventional measures if it proves necessary, especially if the outlook were to deteriorate significantly.

The Obama Administration is proposing more government fiscal stimulus spending to boost the economy.
The only thing these policies have achieved is the destruction of capital.
The Fed and other central banks have been printing money to pump liquidity into their economies. These policies aren’t working. Credit is declining, money supply is declining, and the creation of fiat money is destroying capital by devaluing currencies.
Massive government spending on politically favored projects adds nothing to the economy and destroys more capital. One need only look at U.S. stimulus spending at Recovery.gov to see where the billions are going. If it worked the economy would be growing and unemployment would be declining. The opposite is happening.
How does repairing a highway in Ohio lead to economic growth? The answer is that it won’t; once the money is spent, the repair jobs go away and the capital is gone.
Is it possible that the private economy would find better things to do with that capital? We need to ask what the person whose capital was taxed away by the government was going to do with it. I am sure that the answer would be that it would be preserved or used for new economically viable businesses. Only savings, not spending, creates capital for renewed growth by private enterprise.
Eventually governments run out of capital if they dominate their economies long enough. High taxes and a welfare state lead to lower incentives to produce and lower incentives to save. Most of these countries are still spending the capital earned in former, freer market economic times. If they destroy enough capital they will go bankrupt and plunge their economies into serious depressions.
The outcomes of policies that destroy capital will vary from country to country, but none of them will be good. In the U.S. we can look forward to stagflation: years of high unemployment, low productivity, and rising inflation. Japan will continue its 20-years of low productivity and deflation. China will experience capital destructive boom-bust cycles. Germany may be the sanest of all by ignoring the conventional Keynesian wisdom by cutting government spending.
A sobering thought is that these capital destroying policies are being exported to developing countries as well. As these economies emerge from controlled economies to freer systems, they need time to amass capital to drive their growth. Most advanced economies experienced a century or more of rather hands-off capitalism before they turned into welfare states and regulated economies. China cannot morph into a dynamic capitalistic economy by burning up capital of its entrepreneurs through graft, wasteful spending, and harsh regulations.
There is no refuge from the world’s plunge into massive capital destruction. At one time in history you could flee to countries with freedom and free markets, such as America. With the globalization of Neo-Keynesian economics, there is no refuge. Watch out for EMDs: the economics of mass destruction is here.

Shadow Banking System Is Collapsing, Credit Contracting

from Zero Hedge:

Continuing the analysis of today's Z.1 report, we next focus on recent developments in the shadow banking system. And it's a bloodbath: total shadow bank liabilities dropped by $680 billion in Q2, and a massive $2.1 trillion YTD. If one wonders why Ben Bernanke (yes, it's technically TurboTim) continues to print trillions and trillions of debt, and it is still doing nothing (yet) to stimulate the system, here is your answer.
As credit will only exist if i) it is needed and ii) there are cash paying assets (or at least the myth thereof) to support its existence, the latest plunge in the shadow banking system is merely the most recent confirmation that the deleveraging in America is only just beginning. In fact, from the peak of the credit bubble in Q2 2008, through Q2, total bank liabilities (shadow and traditional) have plunged by $2.6 trillion, from $32.1 trillion to $29.5 trillion. Yet it is the collapse in shadow banking that was responsible, with shadow liabilities falling by a stunning 20% from $21 trillion to $17 trillion in just over two years even as banks have benefitted from the transfer of cheap government cheap on their traditional lending books (think Fed intervention and QE, leading to record low interest rates).
What this means is very clear: the shadow banking system is collapsing, period. Yes, the rate of collapse is slower than in Q1, but the total plunge was still a whopping $4.2 trillion annualized for 2010. And the delta between Shadow Banking and Traditional liabilities has collapsed from $10.7 trillion at the peak in March 2008, down to under $4 trillion. This is a record amount of "money" being removed from the system, and explains why, for now at least, the velocity of money is nothing faster than a crawl.
That said, if and when this indicator plateaus and recommences climbing, will be a very "sensitive" moment for all deflationists and inflationists as it will mark the inflection point from credit contraction to renewed credit creation. Alternatively, the Fed can merely force credit into traditional bank liabilities, which banks can then proceed to use and purchase stocks and commodities, at a zero cost of debt. What that will do to select asset prices, we leave to our readers' imagination.
Chart 1: Total sub-components of the shadow banking system

Chart 2: Comparison of shadow banking and traditional commercial bank liabilities

Chart 3: Consolidated shadow and commercial bank liabilities and sequential change